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1 C h a l l e n g e U s

2 LANDMARK INTERNATIONAL TAX RULINGS AN INDIAN PERSPECTIVE International Tax Conference PHD Chamber September 5, 2014 Parul Jain, Partner

3 YANKO WEISS ISRAELI TEL- AVIV COURT

4 YANKO WEISS Facts of the case I Co was a company incorporated in Israel held by Shareholders two shareholders Mr Yanko and Mr Weiss (along 1 with their wives) who were tax-residents of Israel I Co Migration I Co It purchased modest real estate in Belgium and migrated its registered office to the country Sufficient substance in I Co it had local Property, local managers etc managers, architects, legal and financial consultants in the country; maintained a bank account therein Sub Co Belgium Post migration, I Co sold shares of its subsidiary Sale of shares post migration to Belgium 2 Acquirer Israel (Sub Co) to another Israeli corporation (Acquirer) I Co claimed Israel would not have a right to tax capital gains as it was a resident of Belgium under the Israel-Belgium tax treaty (Treaty) YANKO WEISS 4

5 YANKO WEISS (CONT) Contentions of Tax authorities The Israeli Income-tax Assessor argued I Co Shareholders should qualify as a tax-resident of Israel by virtue 1 of the control and management test I Co Migration I Co Actual control and management of I Co vested with its shareholder Mr Yanko. Accordingly, I Co to qualify as a tax-resident of Israel Property, local managers etc Decision of the Court No strict definitions of the term control and management interpretation dependent upon Sub Co Belgium factual matrix of the case at hand Sale of shares post migration to Belgium 2 Acquirer Israel Decisions on I Co s business policies, strategic decisions etc taken by Mr Yanko I Co s funds (controlled by Mr Yanko) held to be merely transferred from the company s coffers in Israel to the company s coffers in Belgium indicated supreme managerial authority YANKO WEISS 5

6 YANKO WEISS (CONT) Decision of the Court (cont) Substantial documentary evidence such as letters Shareholders of correspondence, exchanges and minutes 1 of cross examination of Mr Yanko, Mr Weiss and I Co Migration I Co local Belgian managers of I Co relied upon by the Court to arrive at a decision Mutual Agreement consultation process under the Property, local managers etc Article 25 of the Treaty invoked real functioning process of I Co confirmed by Belgian tax authorities Sub Co Belgium I Co accordingly held to be a tax-resident of Israel 2 Israel and liable to tax on capital gains earned by it therein Sale of shares post migration to Belgium Acquirer Landmark judgment emphasises upon the real substance of a transaction rather than its legal form YANKO WEISS 6

7 AN INDIAN PERSPECTIVE What the case law means in the Indian context? Basic principle of control and management interpreted to mean controlling and directive power the head and the brain in a catena of judicial precedents De-facto control and not de-jure control held to be determinative of control and management Examination by Indian Courts and Appellate forums more so in the context of residency of a foreign enterprise purporting to avail tax-treaty benefits Documentation such as minutes of the meetings of the board of directors etc given due weightage in determining the location on controlling and directive power Concept of establishing residency of a foreign enterprise of particular importance in Indian context due to widespread migrations by foreign enterprises to tax-efficient jurisdictions It would be interesting to see what the future holds for India post advent of the Direct Taxes Code introducing a concept of place of effective management in the context of tax residency of an enterprise YANKO WEISS 7

8 RE US S CORP GERMAN FEDERAL TAX COURT (BFH)

9 RE US S CORP Facts of the case A US S corporation (S Corp) - treated as fiscally Members transparent for US tax purposes) owned 50 percent share in a German resident company (G Co) It received in the subject tax year, dividend income from G Co that withheld taxes (WHT) at the applicable tax rate (approximately 21 percent) S Corp S Corp applied for a refund of WHT on the premise that it beneficially held more than 10 percent of the Payment of dividend 50% USA Germany capital of G Co and should accordingly be eligible for a concessional withholding on dividends (at the rate of 5 percent) under the US-Germany tax treaty (Treaty) 1 G Co Refund granted by German tax authorities only on the basis of a 15 percent rate available to all other shareholders RE US S CORP 9

10 RE US S CORP (CONT) Contentions of Tax authorities S Corp was not a resident under the Treaty for: Members It was not a taxable entity for Treaty purposes Its income was subject to tax in the hands of its shareholders and could therefore not be considered liable to tax in USA Unlike the erstwhile 1989 version of the Treaty which specifically provided for the residential S Corp status of a partnership firm (whose partners were subject to tax in either of the contracting states), Payment of dividend 50% USA Germany the amended Treaty (amended by a protocol in 2006) did not contain a specific provision to deal with hybrid entities. Decision of the Court 1 G Co Three broad principles analysed by the Court: Recipient of dividend to be a company in accordance with Treaty provisions; RE US S CORP 10

11 RE US S CORP (CONT) Decision of the Court (cont) Recipient of dividend to be a resident of the Members other contracting state; and Recipient to be the beneficial owner of dividends so received On recipient being a company: S Corp being treated as body corporate and fiscally nontransparent from a German (ie source country) tax S Corp perspective - to qualify as a company under the Treaty Payment of dividend 50% USA Germany On residency: Article 1(7) of the Treaty sufficient in its import to hold S Corp as a deemed resident of USA; Further, as dividend taxed within USA (at the level of the shareholders), S Corp to be held 1 G Co liable to tax in USA RE US S CORP 11

12 RE US S CORP (CONT) Members S Corp USA Decision of the Court (cont) On beneficial ownership: Germany treated S Corp as a person subject to limited tax liability in Germany with regard to dividend income onus of such tax liability enough to treat S Corp as the beneficial owner of dividends for Treaty purposes Meaning of the word derived by used in Article 10(2) of the Treaty not examined despite flowthrough status of S Corp Accordingly, S Corp adjudged eligible to beneficial WHT rate (of 5 percent) under the Treaty Payment of dividend 50% Germany 1 G Co Decision to have wide ramifications for all hybrid entities such as LLPs and LLCs that are treated as fiscally transparent in their respective states of residence RE US S CORP 12

13 AN INDIAN PERSPECTIVE What the case law means in the Indian context? Indian Courts and Appellate forums have examined taxability of hybrid entities in the context of whether they can be held as liable to tax in their respective states of residence Issue at hand literal vs liberal construct? if residence state s right to tax income sufficient to hold a fiscally transparent entity liable to tax in the state of residence? Object of tax treaties (of avoidance of double taxation) held frustrated where treaty benefits denied to fiscally transparent entities principle upheld by the Canadian Tax Court judgment of TD Securities (USA) LLC v Her Majesty the Queen [2010 TCC (186)] and the Vienna Convention followed by Indian Courts and Appellate forums OECD view - a fiscally transparent partnership not to be considered as liable to tax in the residence jurisdiction partners to be eligible to treaty entitlement Diverse opinions of Indian Courts and Appellate forums in this regard: Linklaters LLP v ITO (2010)(40 SOT 51) (Mumbai Tribunal): Taxability of income in a state rather than mode of taxability imperative in determining residence for treaty purposes accordingly treaty benefits held available to fiscally transparent partnership RE US S CORP 13

14 AN INDIAN PERSPECTIVE (CONT) What the case law means in the Indian context? (cont) Scellenberg Wittmer In Re (2012)(210 Taxman 319)(AAR): Definition of the term person in the India-Switzerland tax treaty inclusive; the expressions body of individuals or any other entity qualified by the expression which is taxable under the laws in force in either contracting state. Partnership firm being fiscally transparent accordingly not taxable as per Swiss laws and thus ineligible to treaty benefits. Further, absence of specific enabling provision re taxability of fiscally transparent entities in the India-Switzerland tax treaty highlighted Couple of recent rulings rendered by Indian Courts post Scellenberg fortifying the Linklaters principle Change in perspective of Indian Courts and Appellate Forums post the German BFH ruling would indeed be interesting to observe! RE US S CORP 14

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